Top issues- the financial reporting, operational and business impacts of insurance accounting modernization.

1. www.pwc.com/us/insurance
January 2017
The financial reporting, operational and business
impacts of insurance accounting modernization

2. 2 top issues
The financial reporting, operational and
business impacts of insurance accounting
modernization
Modernization of insurance
accounting is finally here. The
FASB issued its final guidance on
enhanced disclosures for short
duration contracts in May of 2015
and published an exposure draft
in September of 2016 on targeted
improvements to the accounting
for long-duration contracts.
After literally decades of deliberations,
the IASB has completed its most recent
exposure draft and plans to issue a final
comprehensive accounting standard in
the first half of 2017. Moreover, additional
changes in the statutory accounting for
most life insurance contracts are coming
into effect; a company can elect to
have Principles Based Reserving (PBR)
effective on new business as early as
January 1, 2017. Companies have three
years to prepare for PBR with all new
business issued in 2020 required to be
valued using PBR.
The impact of these regulatory changes
is likely to be significant to financial
reporting, operations, and the business
overall. Instead of approaching
accounting modernization as a
compliance exercise, companies instead
should view the changes holistically,
with an understanding that there will
be impacts to systems, processes, profit
profiles, capital, pricing, and risk.
Planning effectively and building a case
for change can create efficiencies and
enhanced capabilities that benefit the
business more broadly.
Financial reporting
modernization will affect the
entire organization, not just the
finance and actuarial functions.
Operations and systems;
risk management; product
development, marketing and
distribution; and even HR will
need to change.

3. 3 top issues
FASB’s Targeted Changes
In May of 2015, the FASB issued
Accounting Standards Update
(ASU) 2015-09, Disclosures about
Short-Duration Contracts.
Rather than changing the existing
recognition and measurement guidance
in U.S. GAAP for short-duration contracts,
the FASB responded to views from
financial statement users by requiring
enhanced disclosures for the liability for
unpaid claims and claims adjustment
expenses. The disclosures include annual
disaggregated incurred and paid claims
development tables that need not exceed
ten years, claims counts and incurred
but not reported claim liabilities for
each accident year included within the
incurred claim development tables, and
interim (as well as year-end) roll forwards
of claim liabilities.
The enhanced disclosures will be
effective for public business entities for
annual reporting periods beginning
after December 15, 2015 (i.e., 2016 for
calendar year end entities) and interim
reporting periods thereafter. The new
disclosures may require the accumulation
and reporting of new and different
groupings of claims data by insurers
from what is currently captured for US
statutory and other reporting purposes.
Public companies are currently preparing
now by making changes to existing
processes and systems and performing dry
runs of their processes to produce these
disclosures. Non-public business entities
will have a one year deferral to allow
additional time for preparation.
In September of 2016, the FASB issued a
proposed ASU on targeted improvements
to the accounting for long-duration
contracts. Proposed revisions include
requiring the updating of cash flow
assumptions and use of a high-quality
fixed income discount rate the maximizes
the use of market observable inputs in
calculating various insurance liabilities,
simplifying the deferred acquisition costs
amortization model, and requiring certain
insurance guarantees with capital market
risk to be reported at fair value. The
FASB also proposed enhanced disclosures
which include disaggregated rollforwards
of certain asset and liability balances,
additional information about risk
management, and significant estimates,
input, judgments, and assumptions
used to measure various liabilities and
to amortize deferred acquisition costs
(“DAC”). No effective date was proposed,
and transition approaches were provided
with the recognition that full retrospective
application may be impracticable.

4. 4 top issues
IASB to issue a new comprehensive
standard
The IASB’s journey to a final,
comprehensive insurance
contracts standard is nearly
complete. After reviewing feedback
from field testing by selected
companies in targeted areas, the
IASB completed its deliberations
in November of 2016.
The IASB staff is proceeding with drafting
IFRS 17 (previously referred to as IFRS 4
Phase II) with a proposed effective date
of January 1, 2021. Three measurement
models are provided for in the standard:
1) Building Block Approach (“BBA”); 2)
Premium Allocation Approach (“PAA”);
and 3) the Variable Fee Approach
(“VFA”).
The default model for all insurance
contracts is the BBA and is based on a
discounted cash flow model with a risk
adjustment and deferral of up-front
profits through the Contractual Service
Margin (CSM). This is a current value
model in which changes in the initial
building blocks are treated in different
ways in the P&L. Changes in the cash
flows and risk adjustment related
to future services are recognized by
adjusting the CSM, whereas those related
to past and current services flow to the
P&L. The CSM amortization pattern is
based on the passage of time and drives
the profit recognition profile. The effect
of changes in discount rates can either
be recognized in other comprehensive
income (OCI) or P&L.
The IASB has also allowed for the use
of the PAA for qualifying short term
contracts, or those typically written by
property and casualty insurers. This
approach is similar to an unearned
premium accounting for unexpired risks
with certain differences such as deferred
acquisition costs offsetting the liability
for remaining coverage rather than
being reflected as an asset. The claims
liability, or liability for incurred claims, is
measured using the BBA without a CSM.

5. 5 top issues
Discounting of this liability for incurred
claims would be required, except where a
practical expedient applies for contracts
in which claims are settled in one year
or less from the incurred date. Similar to
the BBA model, the effect of changes in
discount rates can either be recognized in
other comprehensive income (“OCI”) or
the P&L.
The VFA is intended to be applied to
qualifying participating contracts.
This model was subject to extensive
deliberations, considering the prevalence
of such features in business issued by
European insurers. This model recognizes
a linkage of the insurer’s liability to
underlying items where the policyholders
are paid a substantial share of the returns,
and a substantial proportion of the cash
flows vary with underlying items. The
VFA is the BBA model but with notable
differences in treatment including the
changes in the insurer’s share of assets
being recognized in the CSM, accretion
of interest on CSM at current rates, and
P&L movements in liabilities mirroring
the treatment on underlying assets with
differences in OCI, if such an option is
elected.
The income statement will be transformed
significantly. Rather being based on
premium due or received, insurance
contract revenue will be derived based on
expected benefits & expenses, allocation
of DAC, and release of the CSM and risk
adjustment. The insurance contracts
standard also requires substantial
disclosures, including disaggregated
rollforwards of certain insurance contract
assets and liability balances.
Forming a holistic strategy and
plan to address accounting
changes will promote effective
compliance, reduce cost and
disruption, and increase
operational efficiency, as well
as help insurers create more
timely, relevant, and reliable
management information.

6. 6 top issues
Statutory accounting:
The move to principles-based reserving
The recently adopted Principles-
Based Reserving (“PBR”) is a
major shift in the calculation
of statutory life insurance
policy reserves and will have far
reaching business implications.
The former formulaic approach
to determining policy reserves is
being replaced by an approach
that more closely reflects the risks
of products. Adoption is permitted
as early as 2017 with a three year
transition window. Management
must indicate to their regulator if
they plan on adopting PBR before
2020. Retrospective adoption
for business in the three-year
transition window.
PBR’s primary objective is to have reserves
that properly reflect the financial risks,
benefits, and guarantees associated with
policies and also reflect a company’s
own experience for assumptions such
as mortality, lapses, and expenses. The
reserves would also be determined
assessing the impact under a variety of
future economic scenarios.
PBR reserves can require up to three
different calculations based on the risk
profile of the products and supporting
assets. Companies will hold the highest
of the reserve using a formula based net
premium reserve and two principle-based
reserves – a Stochastic Reserve (SR) based
on many scenarios and a Deterministic
Reserve (DR) based on a single baseline
scenario. The assumptions underlying
principles-based reserves will be updated
for changes in the economic environment,

7. 7 top issues
changes in company experience, and for
changes in margins to reflect the changing
nature of the risks. A provision called the
“Exclusion Tests” allows companies the
option of not calculating the stochastic or
deterministic reserves if the appropriate
exclusion test is passed. Reserves under
PBR may increase or decrease depending
on the risks inherent in the products.
PBR requirements call for explicit
governance over the processes for
experience studies, model inputs and
outputs, and model development, changes
and validation. In addition, regulators
will be looking to perform a more holistic
review of the reserves. Therefore, and
as we noted in the 2015 edition of this
publication, it is critical that:
• The PBR reserve process is auditable,
including the setting of margins and
assumptions, performing exclusion
tests, sensitivity testing, computation
of the reserves, and disclosures;
• Controls and governance are in place
and documented, including assumption
oversight, model validation, and model
risk controls; and
• Experience studies are conducted with
appropriate frequency and a structure
for sharing results with regulators is
developed.
PBR will introduce volatility to life
statutory reserving causing additional
volatility in statutory earnings. Planning
functions will be stressed to be able to
forecast the impact of PBR over their
planning horizons because three different
reserve calculations will need to be
forecast.
There is no “one size fits all”
approach to addressing the
FASB’s and IASB’s changes.
Each company will likely be
starting from a different place
and may have different goals
for a future state.

8. 8 top issues
Implications
A company’s approach to
addressing these changes can vary
depending on a variety of factors,
such as the current maturity
level of its IT architecture and
structure, potential impact of
proposed changes on earnings
emergence and/or regulatory
capital, and current and planned
IT and actuarial modernization
initiatives. In other words, there
is no “one size fits all” approach to
addressing these changes.
Each company likely will be starting from
a different place and may have different
goals for a future state. A company should
invest the time to develop a strategic plan
to address these changes with a solid
understanding of the relevant factors,
including similarities and differences
between the changes. In doing so,
companies should keep in mind the
following potential implications:
Accounting Financial
Reporting
• Where accounting options or
interpretations exist, companies should
thoroughly evaluate the implications
of such decisions from a financial,
operational, and business perspective.
Modelling can be particularly useful in
making informed decisions, identifying
pros and cons, and facilitating
decisions.
• Financial statement presentation,
particularly in IFRS 17, could change
significantly. Proper planning
and evaluation of requirements,
presentation options, granularity of
financial statement line items, and
industry views will be essential in
building a new view of an insurer’s
financial statements.
• Financial statement disclosures could
increase significantly. Requirements
such as disaggregated rollforwards
could result in companies reflecting
financial statement disclosures,
investor supplements, and other
external communications at lower level
than previously provided.
• Change is not limited to insurance
accounting. Other areas of accounting
change include financial instruments,
leasing, and revenue recognition. For
example, the impact of changes in
financial instruments accounting will
be important in evaluating decisions
made for the liability side of the
balance sheet.
Operational
• Inherent in each of these accounting
changes is a company’s ability to
produce cash flow models and utilize
data that is well-controlled. Companies
should consider performing a current
state assessment of their capabilities
and leverage, to the extent possible,
infrastructure developed to comply

9. 9 top issues
with other regulatory changes
such as Solvency II and ORSA and
identify where enhancements or new
technology is needed.
• Given the increased demands on
technology, computing and data
resources that will be required, legacy
processes and systems will not likely
be sufficient to address pending
regulatory and reporting changes.
However, this creates an opportunity
for these accounting changes to
possibly be a catalyst for finance and
actuarial modernization initiatives
that did not historically have sufficient
business cases and appetite internally
for support.
• As these accounting changes are
generally based on the use of current
assumptions, there will be an increased
emphasis on the ability to efficiently
and effectively evaluate historical
experience on products by establishing
new or enhancing existing processes.
Strong governance over experience
studies, inputs, models, outputs, and
processes will be essential.
• As complexity increases with the
implementation of these accounting
changes, the impact on human
resources could be significant.
Depending on how many bases of
accounting a company is required
to produce, separate teams with the
requisite skill sets may be necessary
to produce, analyze, and report the
results. Even where separate teams
are not needed, the close process will
place additional demands on existing
staff given the complexity of the new
requirements and impact to existing
processes. Companies may want to
consider a re-design of their close
process, depending on the extent of the
impacts.

10. 10 top issues
Business
• Product pricing could be impacted
as companies consider the financial
impacts of these accounting changes
on profit emergence, capital, and
other internal pricing metrics. For
instance, the disconnect of asset yields
from discounting used in liabilities
under US GAAP and IFRS could result
in a different profit emergence or
potentially create scenarios where
losses exist at issuance.
• Companies may make different
decisions on asset liability matching
or choose to hedge risk on products
differently. Analysis should be
performed to understand changes
in the measurement approach with
respect to discount rates and financial
impacts of guarantees such that an
appropriate strategy can be developed.
• The move to accounting models
where both policyholder behavior
and market-based assumptions
are updated more frequently will
likely result in greater volatility in
earnings. Management reporting,
key performance indicators, non-
GAAP measures, financial statement
presentation disclosure, and investor
materials will need to be revisited such
that an appropriate management and
financial statement user view can be
developed.
• The impact from a human
resources perspective should not be
underestimated. Performance-based
employee compensation plans which
are tied to financial metrics will likely
need to change. Employees will also
need to receive effective training on the
new accounting standards, processes,
and systems that will be put in place.
Forming a holistic strategy and plan
to address these changes will promote
effective compliance, reduce cost and
disruption, and increase operational
efficiency, as well as help insurers create
more timely, relevant, and reliable
management information. Given the
pervasive impact of these changes, it is
important that companies put in place
an effective governance structure to help
them manage change and set guiding
principles for project. For example, this
involves the development of steering
committees, work streams, and a project
management office at the corporate and
business group level that can effectively
communicate information, navigate
difficult decisions, resolve issues, and
ensure progress is on track. Each company
has a unique culture and structure,
therefore, governance will need to be
developed with that in mind to ensure it
works for your organization. Companies
that do not plan effectively and establish
effective governance structures are
likely to struggle with subpar operating
models, higher capital costs, compliance
challenges, and overall competitiveness.

11. www.pwc.com/us/insurance
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Contacts
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PBR
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